Merlin Weekly Macro: Trump is using tariffs as political levers

It is difficult to escape the topic of tariffs. The subject is the daily bread of the media. It links directly with economic effects and stock market reactions; it was a consideration in the Bank of England deciding to cut interest rates to 4.5%, ‘The Committee noted that this [i.e. Trump’s tariffs] was a rapidly evolving situation, which it would be monitoring closely, and that the ultimate impact would depend on the final composition of policies’.

Many trees have been sacrificed to provide acres of newsprint, particularly as offended parties respond to Donald Trump’s tariff torrent as though he was the inventor of these economic weapons of mass destruction. He is not. Go back to the dawn of trade when the first goat was exchanged for a bushel of wheat, sure as eggs someone, somewhere, was already hard at work inventing customs duties, trade tariffs and other measures either defensively or for advantage or from which to raise revenue. They have been used ever since.

Learning the hard way

As we have pointed out before, the apparent novelty of the current tariff spat is largely a result of the almost complete absence of western political muscle memory of dealing with Trump. Only Macron among the main national leaders in Europe and Japan was in office in Trump’s first term. There is the famous photograph from the G7 summit in Reykjavik in June 2018 when Trump refused to sign the kumbaya-all-sweetness-and-light joint statement about cooperation including trade, when he had just slapped tariffs on most of those present. He is sitting, a picture of innocence, arms crossed, surrounded by bemused heads of government standing glowering, and an angry Angela Merkel leaning aggressively towards him across the table. He simply did not budge. But apart from Macron, they are all gone and to their successors, it still seems a great surprise that a demonstrably single-minded, non-consensual Trump says what he means and means what he says, and does it.

Confected outrage

Today, however indignant the injured counterparties might feel at being singled out for Trump’s special attention, the fact is that almost every trading nation on the planet deploys such instruments habitually. The Geneva Convention prescribes the rules for maintaining a level of civility in armed conflict; the economic equivalent is the World Trade Organisation (WTO) and the General Agreement on Tariffs and Trade (GATT). Only four countries are not party to the WTO: The Vatican, Ethiopia, Cape Verde and The Yemen. The rule book is a door-stopper, immensely comprehensive and minutely detailed. While the WTO has wide powers to ensure compliance, its authority stops at being able to challenge or prevent a country deploying tariffs for reasons of national security. Trump plays the rule book: it is why, as well as trade, he always links the tariff imposition with for example what he sees as the threats posed by illegal immigration or the export of banned narcotics to the US, or the extent to which the US pays for or underwrites the target country’s national defence.

While compliance with fair trade is assumed, some countries deliberately stretch or exceed the boundaries. Fair trade is impeded when what are deemed illegal subsidies are used by a commercial party deliberately and unfairly to under-cut the competition. That was the charge laid against Chinese car makers by the EU in 2024 when they were found to be flooding the European market with electric vehicles sold at uneconomic prices (the financial shortfall made up by the Chinese government, hence the illegal subsidy) with the aim of causing financial distress to European competitors. Targeted by company, retaliatory tariffs ranging from 35.3% were applied to SAIC down to 7% for Tesla (China) depending on the severity of their contravention. It is therefore ironic that without batting an eyelid, China’s response to Trump’s new 10% tariff rate included a complaint to the WTO.

The Three ‘C’s: Cars, Chickens and Cows

Trump complains loudly of the ‘atrocity’ of the EU, railing against the imbalance of trade, that the bloc doesn’t buy ‘US cars and American farm products, they take almost nothing, we take everything’. He knows why with agricultural products. He simply disagrees with the reason: the EU refuses entry to US beef which it suspects of being pumped to the eyeballs with growth hormones and drenched in anti-biotics, and likewise turns away processed chicken washed in chlorine. Americans happily consume vast quantities of both. The US rejects the science and deems the trade barrier as simply a measure of protecting inefficient EU farmers from fair competition from lower cost producers in the US who can sell at much more competitive prices because of intensive practices rather than government subsidies. That same toxic meat impasse has been the Gordian Knot in the free trade talks between the US and the UK since Brexit.

As for cars, both the UK and the EU charge a 10% tariff on imported US vehicles. Sales are not high (though there is economic benefit to the US, particularly from Ford which manufactures extensively across Europe). Perhaps it is a hangover from the days when US automobiles were vast, badly damped, gas-guzzling boulevard cruisers, too big for most European roads and too expensive to run with much higher petrol costs, that US imports are limited. On the other hand it says much that at $17bn in 2022 the US was Germany’s second biggest export market for cars by value (overtaken by China with $20.5bn) and ahead of the UK with $12.3bn. Going the other way, US automotive exports to Germany were $6.7bn (and the UK, $0.8bn, less than 2% market share); the $10bn German surplus in car trade with the US cannot simply be down to a 10% tariff applicable in the EU. It might just be that Germany makes better cars that more people want to buy.

Free to do our own thing; fancy that!

On a windy, noisy airport tarmac, Trump declared that ‘the UK is outta line, the European Union is way outta line, but the UK, I think we can work that out’. What is important is not that we are ‘outta line’ with Trump’s expectations of us, it is the fact that he can deal with the UK directly. This is the economic Voldemort factor (the One We Do Not Mention): a real benefit of Brexit.

Thanks to Brexit, the UK is no longer in the EU Customs Union and therefore can negotiate its own bilateral free trade arrangements. It was the Polish foreign minister Radoslaw Sikorski speaking from the EU summit this week who spelled out the reality of the Customs Union when interviewed about his reaction to Trump’s likely tariffs against the EU: ‘I cannot comment. Every member of the Customs Union has ceded sovereignty on trade to the European Commission. You must ask the Commission. Only they can comment’. Ceding sovereignty is the quid pro quo of the free movement of goods within the Union. We retain sovereignty.

Risk: looking beyond the purely economic

It is the nature of the beast that markets distil all this down to how trade flows might be affected and what it does to the outlook for inflation, growth and interest rates (the ‘count it, model it, value it’ preoccupation). The results are reflected in bond yields, interest rates, the price of gold, and more idiosyncratically with companies identified as being either winners or losers.

But there is a wider issue at work here, more to do with the political angle than the economic, but no less important when it comes to assessing risk. Trump’s tormenting tariffs are designed deliberately to provoke a reaction from each and every target. Not everything has gone Trump’s way, but that is part of the calculation. Canada and Mexico have both taken steps to strengthen border controls to help reduce the flow of illegal immigrants and narcotics into the US in accordance with Trump’s wishes, earning themselves a one-month reprieve. The EU is rattling sabres but at the time of writing has nothing concrete against which to fight until Trump announces his ‘retaliatory’ action. China on the other hand has already retaliated with tit-for-tat tariffs and an investigation into the practices of big US tech companies working against the Chinese national interest.

But deliberately lobbing economic hand grenades with the pins out, however successful through Trump’s MAGA lens to create political leverage, is inevitably corrosive, especially when most of the targets are NATO allies. From a diplomatic and security standpoint (and Trump is the antithesis of a diplomat), it is reductive policy.

Starmer: impaling himself on the head of a pin

In the UK, Keir Starmer finds himself being buffeted from both angles. He has publicly stated that he will not side with the EU in any trade war with the US. He still would like a trade deal with America (which is only possible outside the European Customs Union), but his strongly Europhile gut instinct is to get closer to the EU and to align on key regulatory areas including energy. But what is becoming clear, whether through giveaways to the unions (the significant no-strings pay awards), or with significant security implications handing over the Chagos Islands to Mauritius with a handsome, inflation-linked dowry of a minimum of £9 billion potentially rising to £18 billion and nothing in return (the 99-year lease on Diego Garcia is no benefit: we currently own the freehold for nothing with no obligation to give it away!), or making concessions to China (assessed by the Security Services as a Tier 1 Threat to UK national security) over a colossal new 600,000sq ft embassy development on the site of the Royal Mint by the Tower of London, is that Starmer has zero aptitude as a deal-maker. Worse, he exercises almost invariably poor judgement.

He has already very obviously opened his hand that he wants the UK to realign with Europe. That immediately implies he has concessions to offer. The EU wants us back in the fold on security and defence grounds (Poland’s Sikorsky again: ‘on security we miss you and need you’). Yet already, EU leaders are laying down terms that are nothing to do with defence to which they expect the UK to agree as a precondition of our doing Europe the favour of bolstering their security. These include full access to UK waters for EU fishing fleets and free movement of 18-30 year-olds between the UK and the EU; and that is just the start.

Opening negotiations and already putting oneself on the back foot has all the hallmarks of an own-goal. Starmer needs to demonstrate that he is neither a patsy nor a pushover. Trade minister Nick Thomas-Symonds declaring ‘we will be ruthlessly pragmatic’ in the new Brexit re-set talks inspires little confidence. The omens are not good. We will be delighted to be proved wrong.

If we think it is only Donald Trump who plays dirty, the EU is perfectly capable of it too. Think back to the original tortured Brexit negotiations and Brussels’ threat of punitive tariffs (and ‘punishment’ was the explicit language of the day), particularly in the context of the status of Northern Ireland. In France’s national interest, President Macron was not above extra vindictiveness: in the dispute over French access to British fishing grounds off the Channel Islands, he threatened to cut off the electricity supply to Jersey and Guernsey. 10% of the UK’s total electricity consumption is met by direct imports from France; a further 20% is supplied from the UK onshore nuclear generating fleet that is owned by EDF, which is wholly controlled by the French government. It may never be invoked but the lever is still there and the unspoken implication is left hanging.

Starmer is Labour’s Remainer-in Chief (as Jeremy Corbyn’s Shadow Brexit Secretary, Starmer demanded a second referendum to overturn the decision to leave in 2016). But why he wants to open this particular can of worms now is a mystery. Especially with Reform UK and Nigel Farage breathing down his neck. He says it is about growth. With none in Europe (and none here either for that matter: the Bank of England halved its growth forecast to 0.75% for 2025), hitching our nag to the EU’s cart is not the obvious solution.

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